AIFMD Gauging the Impact Thursday, 10 February 2011

INTRODUCTION - housekeeping Introduction Peter Astleford Into the Unknown … Jiří Król, AIMA Depositaries Richard Frase Remuneration, transparency and third country issues Gus Black Impact on fund structures Stuart Martin What can I do to prepare? Peter Astleford QUESTIONS 17335676

Introduction – selected key issues What is an AIFM? Will the proposed directive really have much impact? Europe: a leader or isolated? Impact for America, Asia, etc Different reactions of the PE and other parts of the funds industry Remuneration issues also consider UCITS V 17335676

AIFMD Level 2 Into the unknown? Jiri Krol Director of Policy and Government Affairs Alternative Investment Management Association 4

AIFMD Lamfalussy structure Level 1: Framework directive Level 2: Implementing measures (Commission) Level 3: ESMA guidance Level 4: Commission enforcement Some controversial Level 1 provisions Third countries – passport in 2015, phase out of NPPRs potentially in 2018 Depositaries – liability provisions may drive up costs Remuneration – interplay between CRD III Leverage – maximum leverage must be set at a ‘reasonable’ level Delegation – who is the AIFM? Potential business consequences Increase in compliance costs Restructuring of the prime broker/administrator model Decision to onshore/offshore funds

Level 2 Process Milestones ESMA produces technical advice Commission drafts level 2 measures (Directives or Regulations) Measures discussed at the European Securities Committee Measures consulted with the EP Adoption by the Commission ESMA working methods Public consultation and hearings Impact assessment Organisation of work into sub groups Forms of delegation Delegated Acts Implementing Acts Technical Standards

Level 2 – approximate timeline European Parliament Council of the European Union European Commission ESMA Spring/Summer 2012   Final Level 2 text adopted (COM/MS/EP) Spring/Summer 2011 Consultation on draft technical advice Autumn 2011 Consultation on policy orientations of Commission (not certain) Dec 2010/Jan 2011 Publication of Call for evidence Dec 2011 Mar Apr July Aug Sept Oct Nov 2012 Oct-Feb Mar Autumn 2011/Spring 2012 Discussion with Member States representatives in the European Securities Committee and European Parliament Dec 2010 Mandate for drawing up technical advice Sept 2011 Provision of final advice to COM 7 7

Conclusion Too early to tell where we end up Proportionality is key UCITS/MiFID concepts an inspiration Secondary legislation may favour particular models Could AIFMD turn out to be half as successful as UCITS? Or could it be as useful as the E-money directive?

DEPOSITARIES RICHARD FRASE 17335676

The Depositary The AIFM must ensure a single depositary is appointed for each AIF it manages notify its regulator of the identity of the depositary of each AIF it manages AIF Depositary AIFM Fund Portfolio 17335676

The Depositary (2) The depositary must be an EU credit institution or MiFID firm for a non-EU AIF only, the depositary may be a credit institution, or similar entity subject to effective equivalent prudential regulation and supervision for an AIF with a 5-year investor lock, not investing in custody assets or only normally investing in non-listed companies, the depository may be a firm, subject to mandatory professional registration, which carries out the depositary function as part of its professional or business activities 17335676

The Depositary (3) The depositary must NOT be the AIFM the AIF’s prime broker external valuer portfolio manager, or risk manager unless role is completely separated from its depositary tasks and conflicts of interest are managed and disclosed 17335676

The Depositary (4) The Depositary must be established for an EU AIF in the home state of the AIF for a non-EU AIF, either in the 3rd country where the AIF is established (subject to conditions) in the home state of the AIFM (for a non-EU AIFM – the EU state of reference) 17335676

Depositary Duties Act honestly, fairly, professionally, independently and in the interest of the AIF and its investors Oversee the calculation of the value of the AIF’s units Oversee the AIF’s cash flows Carry out instructions from the AIFM Unless they conflict with applicable law or the AIF’s constitution Remission of consideration and application of income Manage, monitor and disclose conflicts of interest 17335676

The Depositary - delegation AIF AIFM Depositary Prime Broker Sub-Custodians Portfolio of Securities and Cash 17335676

The Depositary - Delegation Delegation is permissible only of safekeeping of custody assets and only if there is no intention to avoid the AIFMD’s requirements an objective reason for the delegation exercise of due skill, care and diligence in the selection and on-going monitoring of the third party 17335676

The Depositary – Delegation (2) On-going assessment that third party meets certain standards adequate structures and expertise prudential regulation and periodic audit segregation and clear identification of assets no use of assets without prior consent of the AIF and notice to the depositary compliance with the AIFMD core custody requirements Exception where third country requires instruments are held in custody by a local entity and there are no local entities satisfying the requirements above Sub-delegation is permissible on the conditions above 17335676

The Depositary – responsibility for AIF assets Depositary has overall responsibility for custody of the AIF’s assets segregation and clear identification of all registrable and bearer instruments Verification of ownership of all other assets and maintenance of up-to-date records No rehypothecation or re-use of assets without prior consent of AIF or AIFM 17335676

The Depositary – responsibility for AIF assets AIFM Depositary Derivatives Positions Derivatives Counterparty 17335676

Liability of the Depositary Liability towards the AIF or its investors for any loss by the Depositary or sub-delegate Defence of force majeure – unavoidable despite all reasonable efforts to the contrary Liability for other losses due to negligence or intentional failure to perform properly duties under the AIFMD Depositary will not be liable for losses of sub-custodian if There is a written contract with the AIF allowing the sub-delegation and evidencing objective reason for same Depositary can prove it met the AIFMD’s delegation requirements; and existence of a written contact explicitly transferring liability and allowing claims to be made 17335676

REMUNERATION TRANSPARENCY THIRD COUNTRY ISSUES GUS BLACK 17335676

“Gauging the impact”

Will the Directive’s missiles hit hard? Remuneration Will the Directive’s missiles hit hard? …or just smoke the budget? Depository Leverage Operational/organisational Remuneration Transparency Marketing / 3rd country 17335676

Remuneration Remuneration policies required for AIFM staff who have a material impact on the risk profiles of AIF they manage. Senior management Risk takers Control functions, etc Prescriptive policy guidance – Annex II Proportionality Disclosure requirements 17335676

Remuneration (2) Some potential impacts At least 50% of variable remuneration paid in AIF interests 40% - 60% of variable remuneration to be deferred for at least 3 years Variable remuneration must only vest if “sustainable” and “justified” 17335676

Transparency point of sale periodic Various disclosure obligations* Annual report Disclosure to Investors point of sale periodic Reporting to Regulators * Broadly apply to EU AIFM and to non-EU AIFM which are marketing to EU investors in respect of each AIF which it manages or markets. 17335676

Investor side letters “No investor may obtain a preferential treatment, unless this is disclosed in the relevant fund’s rules or instruments of incorporation” Preferential treatment, or the right to it, must be disclosed in the fund documentation, including the type of investors benefitting their legal or economic links to the AIF/AIFM a description of the preferential treatment 17335676

Third Country Issues 17335676

Current private placement rules Different approaches state by state Generally works in practice France / Italy / Spain? Reverse Inquiry 17335676

Marketing time line Directive in force (P) 2011 2012 2013 2014 2015 2016 2017 2018 EU AIF obtain passport Non-EU AIF obtain passport? No more private placements? IF ESMA make positive recommendation, and requisite implementing legislation is passed 17335676

AIFM AIF Management Full authorisation and compliance Marketing Home state marketing Passport available straight away 17335676

AIFM AIF Home state marketing (Art 31) AIFM must submit details on each AIF to home regulator If procedure followed - can market within 20 working days Procedure for notification/approval of changes one month prior Marketing only to Professional Investors (except for retail exemption) 17335676

AIFM AIF Marketing in other member states (passport) (Art 32) AIFM must submit details on each AIF to home regulator If procedure followed - can market within 20 working days Procedure for notification/approval of changes one month prior Marketing only to Professional Investors (except for retail exemption) 17335676

AIFM AIF Art 34: Even if the non-EU fund is not marketed in the EU … EU AIFM must comply with all AIFMD requirements except Art 21 (Depository), Art 22 (Annual report) Co-operation agreement in place with the AIF’s regulator A trap for the unwary who thought Directive only catches EU marketing. Careful structuring may be necessary 17335676

AIFM AIF Private placement (Art 36) At member states’ discretion until 2018 (or later) Full Directive compliance (but depository requirements relaxed) Co-operation agreement in place between AIF and AIFM regulators; AIF domicile must not be on FATF non-cooperative list 17335676

AIFM AIF EU feeder into non-EU AIF? (Art 36) Treated as if a non-EU fund (as per previous slide) 17335676

AIFM AIF Marketing passport (Art 35)…. from 2015? EU AIFM must comply with Directive Cooperation agreements; FATF – as for private placement OECD model tax information sharing agreement between AIF domicile and each EU state fund will be marketed in Notification requirements (as for EU funds) at least 20 days prior (but potential for regulators to delay) 17335676

AIFM AIF Non-EU manager delegating to EU manager Can the non-EU manager be the AIFM? MiFID provision / recital 7 No letter boxes allowed role and responsibilities of non-EU manager? substance requirements? 17335676

AIFM AIF Management of EU AIF (Art 37) Requires EU authorisation and Directive compliance (via legal representative in member state of reference) Determination of member state of reference is uncertain 17335676

AIFM AIF Marketing by private placement (Art 40) AIFM must comply with Art 22 (Annual report); Art 23 (disclosure to investors) and Art 24 (reporting to authorities) Cooperation agreement; FATF as before Member states free to impose stricter rules 17335676

AIFM AIF Marketing by passport (Art 38)… from 2015? Requires EU authorisation and Directive compliance (via legal representative in member state of reference) Determination of member state of reference is uncertain Notification requirements similar to marketing by EU AIFM 17335676

AIFM AIF Marketing by passport (Art 39)… from 2015? Requires EU authorisation and Directive compliance (via legal representative in member state of reference) (Art 37) Determination of member state of reference is uncertain Notification requirements similar to marketing by EU AIFM Cooperation agreements; FATF; tax info sharing agreements 17335676

Marketing to Retail Investors – Article 41 Permissible, at the discretion of individual Member States Commission must be notified Stricter requirements may be imposed but no discrimination against cross-border funds Within 3 years, Member States must report to the Commission and ESMA about the operation of their retail regimes 17335676

The view from Midtown…? Business as usual under NPPR (for now) Watching brief on any erosion of NPPR Consider EU authorisation / EU funds if EU market is important 17335676

The view from Mayfair…? Business as usual under NPPR (for now) Investor preference will still drive fund domicile Directive has pros and cons for EU and non-EU fund structures AIFM structuring is crucial 17335676

IMPACT ON FUND STRUCTURES STUART MARTIN 17335676

Impact on Fund Structures It was the best of times, it was the worst of times, it was the age of wisdom, it was the age of foolishness, it was the epoch of belief, it was the epoch of incredulity, it was the season of Light, it was the season of Darkness, it was the spring of hope, it was the winter of despair, we had everything before us, we had nothing before us, we were all going direct to Heaven, we were all going direct the other way ... Charles Dickens, A Tale of Two Cities 17335676

Impact on Fund Structures Is an EU AIFM required? Can the AIF be “self managed”? Impact on “role” of the EU AIFM and relationship with AIF and other service providers Impact on domicile choice Impact of domicile on Fund Structures 17335676

Is an EU AIFM required? AIFM Directive applies to EU AIFM which “manage” EU or non EU AIF Non EU AIFM which “manage” EU AIF; and Non EU AIFM which “market” EU or non EU AIF in the EU “Manage” means providing at least the following Investment Management services when managing an AIF portfolio management; or risk management Concept of each AIFM managed within the Directive having a single AIFM Extends to the marketing passport for non EU AIF managed by non EU AIFM [Art 40 and, if introduced, Arts 38, 39] and May have a helpful wider application 17335676

Is an EU AIFM required? (2) AIFM Directive does not apply to individual portfolio management services provided to AIF under MiFID . . . although such Funds may not be directly or indirectly offered or placed by investment firms in EU, if and to the extent the relevant AIF cannot be marketed in accordance with the Directive MiFID only route may help UK investment manager managing non EU AIF should enable it to manage non EU AIF managed by non EU AIFM marketing under Art 40 (available from TD + 2 + 3 years) 17335676

MiFID Only Structure: Take One Offshore / Non EU Fund Non EU Risk Manager ？ EU Portfolio Manager Full discretion: MiFID only authorisation 17335676

MiFID Only Structure: Take Two Offshore Non EU Fund Discretionary portfolio management Risk management Other “operator” services Offshore Non EU Manager MiFID only authorisation Discretion subject to review by offshore investment manager ? Marketing in EU (policy considerations) ？  EU Portfolio Manager 17335676

Can the AIF be “self managed”? Can an AIF be “self managed” in a similar way to a self-managed UCITS? Under serious discussion in Luxembourg and Dublin Corporate funds e.g. SICAVs and Irish ICVCs Non Corporate Funds e.g. Unit Trusts, FCPs, Limited Partnerships Capital Advantages/Disadvantages Initial capital of €300,000 vs €125,000 Does the “own funds” requirement of 0.02% of assets apply beyond insurance costs? Will a Swiss model of “regulatory capital” apply?  X CLEAR UNCLEAR UNCLEAR -possibly critical 17335676

Can the AIF be “self managed”? Anti Letter Box Provisions AIFM may not delegate functions to the extent it can no longer be considered to be the manager of the AIF and to the extent it becomes a letter box entity What will Level 2 provisions permit? certainly minimum operational and substance requirements at level of the AIF manner of any outsourcing may be relevant may be easier to achieve “self management” by including “risk management” rather than “portfolio management” function within AIF 17335676

Impact on External AIFM Role/Relationship with AIF and Key Fund Service Providers AIFM responsible for portfolio management and/or risk management AIFM may choose to perform the following functions operator functions including : legal and fund management accounting services customer enquiries valuation and pricing regulatory and compliance monitoring maintenance of unit/share register 17335676

Impact on External AIFM Role/Relationship with AIF and Key Fund Service Providers distribution of income contract settlements record keeping marketing activities related to the assets of the AIF 17335676

Impact on External AIFM Role/Relationship with AIF and Key Fund Service Providers But AIFM directly assumes “operational” and “investor facing” operator type obligations eg due diligence etc. in selection and appointment of prime brokers taking steps to identify, prevent, manage and monitor conflicts of interest ensure investment strategy, liquidity profile and redemption policy of AIF are consistent ensure appropriate and consistent procedures are established for the proper and independent valuation of the AIF responsibility for valuation of assets and calculation and publication of net asset value 17335676

Impact on External AIFM Role/Relationship with AIF and Key Fund Service Providers ensure appointment of depositary (possible AIFM liability to investors) preparation of annual report minimum “point of sale” and “periodic” minimum disclosure obligations to investors reporting obligations to competent authorities 17335676

Impact on External AIFM Role/Relationship with AIF and Key Fund Service Providers External AIFM may need to “change” the contractual relationship with the AIF and certain key service providers eg Investment Management Agreement compliance undertakings/authorities from AIF beyond portfolio management matters Administration Agreement potential for AIFM to seek direct compliance undertakings from Administrator Prime Broker and Depositary Agreements Potential for AIFM to be a party to these Agreements Remedies for breach eg resignation? Need to ensure AIFM retains “central management and control” for UK tax purposes 17335676

Impact on Fund Domicile Choice The case for Cayman AIFM managing non EU AIF (no EU marketing) no need to comply with annual report or depositary requirements AIFM managing non EU AIF (EU passport marketing) potential for future access marketing passport from TD + 2 years (with possible delay) AIFM managing non EU AIF (reliance on existing private placement regimes) exemption from certain of the depositary requirements from TD + 2 +3 years The case for an EU domicile possibility of self managed AIF within EU investor sentiment? access to marketing passport from TD vs continuance of private placement regimes for TD + 2 + 3 17335676

Impact of Domicile on Fund Structure Corporate Funds Cayman EU eg Ireland, Luxembourg, Malta (EU ManCo as AIFM) Master Feeder Structures Cayman: master funds may be limited partnerships, unit trusts or corporates which “check the box” Ireland: QIF master funds may be unit trusts, limited partnerships etc. but corporates cannot currently “check the box” but … local regulated management company/general partner required but may be AIFM Luxembourg: SIF master funds may be FCPs or private SICAVs which “check the box” local regulated management company required for FCP but optional for private SICAV. Local management company may be AIFM 17335676

The Master Feeder Structure Non US Investors / US tax exempt investors Onshore (US) Feeder Offshore ManCo / General Partner Offshore Fund (EU/Non EU)* Master Fund* US Taxpayer Investors directly or via US wrapper feeder UK Investment Manager (AIFM/MiFID) If Master Fund is LP Lux / Irish Management Company (AIFM) 17335676

WHAT CAN I DO TO PREPARE? PETER ASTLEFORD 17335676

What can I do to prepare? Consider re-domiciling funds Investors’ preference FIN 48 Dual fund ranges – EU and a second cheaper, better performing non EU range? 17335676

What can I do to prepare? - Alternative Domiciles Ireland Luxembourg Malta UK 17335676

What can I do to prepare? (cont) Consider whether your strategy works in a platform that is outside the scope of the AIFMD UCITS / Newcits managed accounts future staffing needs 17335676

What can those outside the EU do to prepare? Consider setting up/growing an office in Europe there should be time (say 2 years) Consider all delegation currently undertaken would it meet the new requirements? 17335676

Peter Astleford, Gus Black, Richard Frase, Jiří Król, Stuart Martin QUESTIONS? Peter Astleford, Gus Black, Richard Frase, Jiří Król, Stuart Martin 17335676